The present invention relates generally to trading novel commodity options and futures contracts, and more particularly to a device and method for trading such contracts as they relate to athletic and education programs.
Education, particularly higher education, is the gateway to the American Dream. The long-term economic value of earning a college degree is well-documented. College-educated workers, on average, can bring home more than $1 million more over a lifetime than people who end their formal education after high school.
Though benefits of a post-secondary degree are undeniable, consumers of higher education (students and families) have to find a way to cover the price of education before the benefits can be realized. During the past two decades, the price of education in the United States has increased dramatically and at a rate approximately twice the rate of inflation. Between 1980 and 2001, spending at public colleges and universities increased by almost seventy five percent, after accounting for inflation, to over one hundred and thirty five billion dollars.
In addition, student debt obligations have risen dramatically. The average debt fourth year-students at public four-year colleges have accumulated has risen thirty nine percent to over fifteen thousand dollars since 1993. The average debt fourth year-students at private four-year colleges have accumulated has risen forty nine percent to over twenty three thousand dollars since 1993.
In 2005, there were approximately four thousand degree-granting colleges and universities in the United States. In October of 2005, according to the U.S. Department of Labor, there were eleven million sixteen to twenty-four year-olds enrolled in colleges in the United States. This disparity between the supply of and demand for education means that while education is one of the best investments an individual can make, the price risk of education is difficult to hedge because there are many more buyers of education (i.e., students and families) than there are sellers (i.e., colleges and universities). The difficulty related to hedging the price risk of education demonstrates that there is a clear and pressing need for the current invention.
Like the price of education, the price of producing educational athletics, particularly collegiate athletics, in the United States has increased dramatically in the past two decades. At the collegiate level, the amount of revenue that most institutions must allocate from academic resources to balance athletic budgets is increasing. Recent research indicates that the rate of increase in athletic expenditures is tripling that of spending in higher education overall. In other words, the price of athletics is increasing at the equivalent of six times the rate of inflation. It has recently been reported that athletic programs at public institutions receive more than one billion dollars in student fees and general school funds and services. Without outside funding, fewer than ten percent of athletic departments would have been able to support themselves with ticket sales, television contracts and other revenue-generating means. Most of these institutions would have lost more than five million dollars in a single year. Thus, it is clear that the price of athletics is sympathetic with the price of education.
Athletics and education and the business of athletics and education, particularly the business of collegiate athletics, has experienced revenue growth in recent years. Assets related to athletic programs and education programs often generate millions of dollars in revenue. However, the athletic prospects who are the students that contribute to the generation of this revenue do not share in it. Rather, as documented in testimony before Congress in 2003, they often live in poverty. The risk of poverty to prospects who contribute to the generation of athletic revenue demonstrates that there is a clear and pressing need for the current invention.
Furthermore, institutions do not have adequate tools for managing economic risk related to athletic program assets and education program assets. For example, the president of the National Collegiate Athletic Association (NCAA) has publicly stated that Division I collegiate athletics “do[es] not have a sustainable business model” despite the fact that: (a) participating institutions generate millions of dollars via operation of their athletic programs that is not subject to taxation; (b) these institutions do not pay any wages to the athletes who contribute their physical efforts to generating the revenue; and (c) the majority of these institutions provide additional cash subsidies to athletic programs by charging fees to all students attending the institution. In addition, the chairman of the NCAA's Task Force on Fiscal Responsibility has stated that “the rate of growth of expenditures and revenues in intercollegiate athletics simply is not sustainable.” The former chairman of the NCAA's Division I Board of Directors has testified before the Knight Commission on Intercollegiate Athletics (Knight Commission) about the “inequity of the marketplace” for athletic prospects participating in collegiate athletics and has stated that higher education has not “been able to address how to use education as a commodity.” Finally, the former president of the Knight Commission has said that he does not believe that there will be a time when the NCAA or its members “do something so dramatic and wonderful that it really changes the situation.” These statements and findings demonstrate a clear and pressing need for the present invention.
In all collegiate athletic environments, one of the greatest risks to a program is the fierce competition among educational institutions to recruit and retain the most promising athletic prospects in order for an institution to maximize the chances of continuously maintaining an athletic program that is academically, athletically, and economically successful. At the collegiate level, during the off-season (i.e., that time of the year when an athletic program's teams are not engaged in on-field play with competing teams), an institution seeks to persuade desirable prospects to commit to attending that particular institution and participating in the institution's athletic program. Most or all institutions use a standardized contract known as a National Letter of Intent (NLI) to secure a prospect to the exclusion of other competing institutions. According to NCAA Bylaw 13.02.08, the NLI is “utilized by subscribing member institutions to establish the commitment of a prospect to attend a particular institution.”
The NCAA considers the NLI to be a binding agreement between a prospect and an institution in which the institution agrees to provide the prospect a grant-in-aid for one year in exchange for the prospect's agreement to attend the institution and participate in the designated athletic program for that year. The time periods for a prospect to sign an NLI vary by sport. For example, the NLI signing period for college football prospects is open from approximately December 21 through January 15 (for junior college prospects) and approximately February 1 through April 1 (for high school prospects). In the case of football, the prospect who signs an NLI typically delivers himself to the institution by the following July or August. The NLI is binding for a four-year term.
The NLI is a type of unregulated contract known as a forward contract that is similar, but not identical, to a regulated commodity futures contract (also known as a future). A traditional forward contract can be settled only by physical delivery of an underlying commodity and cannot be cash settled. In contrast to a forward contract, most transactions involving futures do not require the seller of the future to actually deliver the underlying commodity to the buyer. Instead, as the last trading date (known as the settlement date) approaches, the buyer and seller execute offsetting contracts, thereby exiting the market and taking a corresponding profit or loss. In other words, a futures contract can be cash settled. These attributes allow a futures contract to mimic the equivalent of real ownership of a commodity without either trader actually obtaining anything but the economic results of the transaction. In general, a future is a standardized contract to buy or sell an underlying commodity or instrument (such as grain, oil, or currency) at a future date and at a set price specified on the last trading date. Unlike traditional forward contracts and unregulated derivative contracts that can be traded on an unregulated over-the-counter (OTC) market, a commodity future can be traded only on a regulated futures exchange known as a designated contract market (DCM).
In a commodity market that underlies a DCM, producers of commodities (such as a grain farmer) and users of commodities (such as a cereal manufacturer) enter into contracts to buy or sell a fixed amount of a particular commodity on a cash (or spot) market. The unpredictable nature of underlying commodities markets led to the development of futures markets as a method for producers and users of commodities to spread the economic risk of price fluctuation and other uncertainties. By trading futures on a DCM, producers and users hedge and manage their economic risk by providing an investment opportunity to investors whose money injects liquidity into the market. By engaging in such a hedging transaction, a producer or user can shift or offset economic risk to the investor seeking economic reward. To offset risk in this manner, a hedging producer or user typically takes on a financial obligation that is opposite to his or her obligation in the underlying commercial transaction.
Hedging is not gambling. In a publication entitled The Economic Purpose of Futures Markets, the Commodity Futures Exchange Commission (CFTC), which is the federal agency with regulatory authority over futures and related options trading in the United States, stated that “[m]any people think that futures are just about speculating or ‘gambling.’ While it is true that futures markets can be used for speculating, that is not the primary reason for their existence. Futures markets are actually designed as vehicles for hedging and risk management, that is, to help people avoid ‘gambling’ when they don't want to.”
In contrast to regulated futures markets, participants in gambling activities do not have any underlying commercial relationship. Unlike regulated futures markets, sports gambling activities cannot have any producers with bona fide hedging interests because laws, rules, regulations, league bylaws, and player contracts prohibit teams and their players from buying or selling a commercial interest in their own performance or in the performance of their rivals. Any potential hedging producer (i.e., a team or player) is strictly prohibited from taking a financial obligation that is the opposite of the obligation to perform to the best of his or her ability in the underlying sporting event. Indeed, in the infamous 1919 World Series, eight members of the Chicago White Sox allegedly sold a commercial interest in their future performance against the Cincinnati Reds and then “shorted” their performance during several games of the World Series competition. Thereafter, the Commissioner of Major League Baseball banned the eight players from organized baseball for life. The whole sports gambling industry is based on the outcome of a sporting event or events as determined solely by the performance of the teams or individuals engaged in the sporting event or events. Thus, instruments that pay dividends that are contractually tied to the underlying performance of a team or individual on a field or court (the output of a team or individual) are not futures, even if such instruments are labeled or referred to as derivative contracts.
An option contract (also referred to as an option) is another type of contract that is traded on a regulated exchange. An option, such as that used in a futures market, is a right, but not an obligation, to buy or sell a future or a commodity at a present fixed price called the exercise price (or strike price). The buyer of an option pays a fixed price, called a premium, to the option writer for this right. A call option is the right to buy a future or a commodity at the strike price, and has positive economic value (also known as in-the-money) when the future market price of the future or commodity is greater than the strike price. A put option is the right to sell a future or a commodity at the strike price, and has positive economic value when the future market price of the future or commodity is less than the strike price.
The price of a regulated commodity contract such as a future or option is established when the contract is made in a trade on a regulated DCM. Numerous such exchanges exist throughout the world. Examples of such regulated exchanges in the United States include The Chicago Mercantile Exchange and The New York Mercantile Exchange. In an exchange's traditional form, buyers and sellers engage in trading through intermediaries such as brokers and merchants who use an open outcry system in an exchange pit (also known as a trading floor). Under this traditional system, the exchange acts as both a clearinghouse and regulator of the market.
The ascendancy of electronic (or computer-based) trading has supplemented (and in some cases supplanted) the open outcry system, increased individual direct access to futures markets, and made it easier for traders to enter and exit futures markets directly. Trading on a DCM can be either intermediated or direct (i.e. non-intermediated). A broker or merchant trades on behalf of and for the benefit of the buyer or seller when trading is intermediated. A buyer or seller trades directly on his or her own behalf and for his or her own benefit when trading is direct. The technological advances mentioned above have increased the feasibility of direct trading of commodity contracts, including direct trading of futures and options.
Futures and options trading is the natural outgrowth of maintaining a continuous supply of seasonal products like agricultural crops. Institutional athletic programs also need a continuous supply of a seasonal product such as NLI commitments. In this regard, the present inventors have recognized that collegiate athletic recruiting markets (as well as collegiate education recruiting markets) function in a manner similar to that of traditional commodity markets.
A prospect and an institution that enter into an NLI are natural counterparties to an illiquid transaction. On one hand, a prospect takes a short position and sells his short-term athletic participation for access to the future earning power of a degree. The institution takes the long position and buys the potential that the athlete will contribute to the long-term athletic and economic well-being of the institution. On the other hand, the prospect can be characterized as the party who takes the long position and buys the potential future return on the institution's academic and athletic programs paying off in the form of a degree and long-term economic prosperity. Under such a view, the institution can be characterized as taking the short position and selling one year of grant-in-aid in exchange for one year of athletic participation and resulting revenue.
The characterization of one party's position as short and the other party's as long is not determinative. Rather, as counterparties, a prospect and an institution have a shared bona fide interest in hedging the risk that the price of the NLI commitment will change for the prospect or the institution after the NLI commitment has been executed. For example, a prospect bears the risk that he or she will live in poverty while participating in athletics and the risk that the demands of athletic participation will take precedence over academic development. The institution takes the risk that its spending on its group of prospects will in the aggregate exceed the economic return to the institution, and the risk that the prospect will not attain an academic degree.
Rival supporters of athletic programs also are natural counterparties. For example, the counterparty to an Ohio State football supporter is a Michigan football supporter or a Penn State football supporter. However, unlike the prospect/institution relationship, rival supporters of college athletic programs have no overlapping long-term interest. For example, when Ohio State competes against Michigan or Penn State on the field during a game, the competition between rival supporters of athletic programs is purely a binary, zero-sum (or winner-take-all) proposition.
The competition between rival supporters of competing institutions is a zero-sum competition because a “win” on a football field or other athletic field or court is a purely rival good or interest (rival interest). A purely rival interest has the property that its use by one precludes its use by another. For example, in a football game between Ohio State and Michigan to determine which of the two teams will compete in a Rose Bowl football game, a successful Ohio State performance that results in a win for the Ohio State football team precludes the use of the win by the Michigan football team. As a result, the Ohio State football team goes to the Rose Bowl and the Michigan team does not. Thus, the win resulting from the Ohio State and Michigan competition is a purely rival interest.
In contrast, an institution's athletic program that consists of an aggregate of athletic teams (e.g., football, basketball, volleyball, field hockey, etc.) is a non-rival, partially excludable interest (non-rival interest) because an athletic program as an organizational unit does not actually compete directly on any field or court with any other institution's athletic program. No meta-competition between athletic programs exists. An interest in an institution's athletic program can be used and enjoyed by any person in the public without limiting the use or enjoyment of any other person's interest in the same athletic program. Thus, an institution's athletic program is non-rival.
A non-rival interest has the property that its use by one firm or person in no way limits its use by another firm or person. A purely non-rival interest cannot be traded in a competitive market. However, a non-rival, partially excludable interest can be traded in a competitive market. Generally, an example of a non-rival, partially excludable interest is a design of a membership organization. For instance, beginning in 1971, the New York Stock Exchange (NYSE) was designed as a private, non-profit association. In 2006, the NYSE merged with Archipelago Holdings, a provider of electronic trading technology, and became a public company. As with other public companies, investors now can trade ownership interests (shares) in the NYSE itself.
Another example of a non-rival interest is a design of an institution's athletic program. Thus, while the Michigan football team's loss to Ohio State precludes the Michigan football team from participating in the Rose Bowl, the outcome in no way limits the interest of any person in either Michigan's athletic program or Ohio State's athletic program. Notwithstanding the outcome of the game, all persons in the public remain free to take a tangible commercial interest in either program or both programs by entering into a contract to sponsor the athletic program or by purchasing tickets to athletic events or by making financial donations to the athletic program(s) or their parent institution(s). In addition, notwithstanding the outcome of the game, all persons in the public remain free to take an intangible interest in either program or both programs by simply rooting for teams sponsored by either athletic program in future athletic events. The design of the NCAA is but another example of a design of a non-rival interest, as is the design of the exchange of the present invention.
No non-rival educational athletic program commodity options or futures currently exist. In addition, no exchange currently exists for an institution, a prospect or the public to hedge their long-term risks related to a prospect entering into an NLI (or related contractual) commitment with a particular institution or to determine the price of an institution's non-rival athletic program. Likewise, no exchange currently exists for the non-NLI students at an institution to manage the risk of the rising cost of education during their years at the institution. Accordingly, it is desirable that a device and method of operating the device be established that facilitates trading non-rival, partially excludable educational athletic program commodity options and futures. It is additionally desirable that such a device and method be established to provide institutions with a tool to manage the risks related to the operation of athletic programs and education programs. It is further desirable that such a device and method be established to provide athletic prospects with a tool to manage the risks related to their participation in athletics, including the risk of living in poverty while participating in athletics. It is further desirable that such a device and method be established to provide the public with a hedge against the increasing price of education. It is further desirable that such a device and method be established to provide institutions with a means for growing revenue. It is further desirable that such a device and method be established to inject liquidity into athletics and education. It is further desirable that such a device and method be established to subsidize the growth of the cumulative effect of higher education (human capital). It is further desirable that such a device and method be established to promote economic growth.